Growth Without Apology

From time to time, countries experience rapid economic growth without a significant decline in poverty. India’s GDP growth rate accelerated in the 1990s and 2000s, but poverty continued to fall at the same pace as before, about one percentage point a year. Despite 6-7 percent GDP growth, Tanzania and Zambia saw only a mild decline in the poverty rate. In the first decade of the 21st century, Egypt’s GDP grew at 5-7 percent a year, but the proportion of people living on $5 a day—and therefore vulnerable to falling into poverty—stagnated at 85 percent.

In light of this evidence, the World Bank has set as its goals the elimination of extreme poverty and promotion of shared prosperity. While the focus on poverty and distribution as targets is appropriate, the public actions required to achieve these goals are not very different from those required to achieve rapid economic growth. This is not trickle-down economics. Nor does it negate the need for redistributive transfers. Rather, it is due to the fact that economic growth is typically constrained by policies and institutions that have been captured by the non-poor (sometimes called the rich), who have greater political power. Public actions that relax these constraints, therefore, will both accelerate growth and transfer rents from the rich to the poor.

Some examples illustrate the point.

Macroeconomic stabilization. Macroeconomic instability undermines growth and hurts poor people. A particular type of instability is when countries run significant current account deficits. In these cases, the real exchange rate is overvalued. But a devaluation is resisted because an overvalued exchange rate makes imports—something the rich consume—cheaper. Meanwhile, the poor, many of whom rely on tradable agriculture for their incomes, suffer. When the currency is finally devalued, as was the case with the CFA Franc in West and Central Africa in 1994, exports and overall growth accelerates, and poverty falls. To be sure, the higher domestic price of imports may hurt the urban poor, but this should be addressed with targeted safety nets, not by persisting with the overvalued exchange rate.

Trade reform. Based on the “infant-industry” argument, many countries protected their industries from import competition with tariffs. Unfortunately, the “infants” never grew up: they were captured by politically powerful people who demanded subsidies to remain in business, without any increase in productivity (the Morogoro shoe factory in Tanzania, for instance, never exported a single pair of shoes). Trade reform raised wages of relatively unskilled workers (who were abundant in poor countries) and lowered returns to capital (owned by the rich) in protected industries. It also stimulated growth because the economy was producing to its comparative advantage (low-skilled labor). The resulting employment creation and cheaper imports led to a decline in poverty. This was the experience of Latin America and East Asia. In Africa, the first wave of trade liberalization ran into difficulty because governments were not prepared for the loss in tariff revenues. Following the introduction of broad-based tax instruments, such as the value added tax, subsequent reforms have had a favorable effect on poverty and growth in Africa. In North African countries like Tunisia and Egypt, trade liberalization was accompanied by the capture of a number of non-tradable industries, such as banking, telecommunications and transport, by the firms connected to the political leaders. The resulting high monopoly prices of non-tradable inputs to the exporting sector meant that exports, and therefore employment, never took off. In this case, the reforms needed to stimulate employment—increased competition in the non-tradable sectors—are the same as those needed to accelerate growth.

Agriculture. In low-income countries, most of the poor earn their living from agriculture. To reduce poverty, we need to increase agricultural productivity, which not only increases poor people’s incomes but also permits some of them to move to higher-productivity occupations in urban areas. The resulting structural transformation leads to higher growth and lower poverty—the pattern that all successful developing countries have followed.

Public action therefore should be aimed at increasing agricultural productivity and facilitating labor’s moving to higher-productivity occupations. Unfortunately, many policies are captured by the non-poor before they can have these effects. For instance, fertilizer subsidies typically go to the largest farmers with only marginal productivity effects. Even when the fertilizer is distributed through the market using a voucher system, a study in Tanzania found that 60 percent of the vouchers went to families of elected officials.

Infrastructure. It is now well-established that infrastructure (bridges, roads, electricity grids, water networks) is important for economic growth. It is also a fact that poor people have the least access to infrastructure. So as a first cut, public action that increases poor people’s access to infrastructure will increase the quantity of infrastructure and generate growth.

But there is a more subtle way infrastructure, growth and poverty interact. Infrastructure services are extremely inefficiently delivered in most countries. Except for South Africa and Kenya, no country in Africa has a solvent electric utility. The reason is that electricity tariffs are considerably below costs. Not only does this underpricing lead to power cuts and dilapidated grids, but it contributes to excluding poor people from the grid. Politicians, who control the utility, make sure the cheap electricity goes to neighborhoods of their political clients. Poor people resort to candlepower, which costs about four times the meter rate. Ironically, increasing tariffs to costs may increase poor people’s access to electricity, because the utility is now accountable to the customer and not the politician. Needless to say, this is also the reason why politicians resist tariff increases.

Education and Health. Another well-established result is that human capital drives a country’s long-term economic growth. And it is the poor, rather than the rich, who lack human capital. The rich have both the incentives and the means to educate their children and keep them healthy. So an increase in the stock of human capital will mean that more poor people get educated and healthy.

The situation is more complicated when we realize that the rich have already captured public resources in both education and health. Governments spend about 200 times as much per student on higher education as they do on primary education. Yet about 60 percent of students at universities come from the richest quintile of the population. Public spending in health is overwhelmingly skewed towards hospitals, the lion’s share of which goes to the richest quintiles. As a consequence, governments under-spend on public goods such as immunization, which are likely to benefit the poor (the rich will immunize their kids without government assistance). Worse still, the quality of primary education and primary health care—which is what matters for poor people’s human capital—is appalling. Teachers in public primary schools in India, Tanzania, Kenya and Senegal are absent about 25 percent of the time; doctors in primary clinics are absent about 40 percent of the time. The people earning these rents—the absentee teachers and doctors—come from the richest 10 percent in their countries. In sum, by rationalizing public spending in health and education towards public goods, and by restructuring incentives to deliver quality services, governments can both enhance growth and reduce poverty.

Almost a century ago, Charles Wilson said, “What is good for the country is good for General Motors—and vice versa.” The present-day equivalent is, “What is good for the poor is good for economic growth—and vice versa.”

Comments

Dear Mr. Devarajan,
Thank you for a well written and simply stated article on growth and poverty reduction. However, I have a comment on your statement on India's rate of poverty reduction in para 1. You state that "India’s GDP growth rate accelerated in the 1990s and 2000s, but poverty continued to fall at the same pace as before, about one percentage point a year." This statement is not true for the decade starting from 2000. The World Bank website on its India page has published the following data. Poverty headcount ratio went down from 37.2% in 2005 to 21.9% in 2012. That means in 7 years poverty went down by 15.3%, making the annual rate of poverty reduction to be 2.18%. You are aware the Indian economy grew at 8 to 9 % during most of this period. India's performance in poverty reduction cannot be compared with Tanzania and Zambia, which have seen commodity led growth with very low growth elasticity of poverty.

Dear Mr. Atheeq: Thank you for your comment. I was using an earlier estimate (also from the World Bank) of India's poverty rate during the 1990s and early 2000s. During this period, growth was over 7 percent and poverty was declining at about one percent a year. You are right that, after 2005, the pace of poverty reduction has picked up. Perhaps this means that poverty reduction accelerates with a lag of about 10 years. Incidentally, while Zambia's growth was commodity-led, Tanzania's was not. It is only recently that Tanzania has become a major mineral producer. Shanta

Well written article. It underpins my argument i had with a friend regarding high GDP growth not necessarily benefitting the entire population of a country. Agreed, a lot more needs to be done on redistribution of the nstional cake.

Dear Mungai: Thanks for your comment. High GDP growth does not necessarily benefit the entire population usually because of high commodity prices (for commodity exporters). These high prices enable the rich to capture the rents, so the poor don't share in the nation's wealth. My point though was that, if you wanted to achieve high growth through public policies (as opposed to waiting for high commodity prices), those policies are the same as those that help the poor.

Sabira, thanks for your question. The overall correlation between democracy and growth (across countries) is not very strong, although it's mildly positive. The relationship with poverty is similarly weak but negative, because of growth's strong effect on poverty reduction. Even at the micro level, the existence of democracy does not guarantee against the capture of rents by elites. The reason is that elections are not a fool-proof way of citizens' holding their leaders accountable. People may vote along ethnic lines, for instance, in which case politicians don't need to deliver results to the poor in order to be elected. Democracy is probably necessary for pro-poor growth, but is clearly not sufficient.

This article sheds so much light on the exact topic being discussed in my undergraduate economics class, 'Economic growth and structural change in Nigeria'. The fact that Nigeria is also a developing country makes its growth pattern very similar to the countries mentioned above. Currently, the growth rate is about 6.5% on the average, yet resources are very poorly distributed, with a widening gap between the rich and poor and Agriculture employing a very large percentage of the labor force, and so on. Thanks a lot for this article. Was doing some research on my class work and I stumbled on this via my email. I hope to see more of such helpful articles.

All these points resonate and reflect what I have seen myself with people we knew well.

India decades ago had very strong incentives for small scale industry development - plots of land in the industrial areas at favorable prices, licenses (in the days of the license raj), electric connections and loans. Rather than benefit the meritorious, what happened was exactly what Shanta described - the well connected and their families got these benefits.

In many cases, these beneficiaries simply resold the land, licenses etc. to actual businessmen at significant profits, sometimes staying on as paper owners.

Where they did try to run these businesses themselves, they generally did not do that well as they had no expertise in that area.

I will attend your coming lecture at Wellesley College. I am a Davis Scholar graduating on 2015 on Environmental Studies and would be grateful for your thoughts on economic models tat are planned specifically to accelerate economic growth that rely on extraction of mineral and natural resources. This is the case in my native country (Brasil) for the past three administrations. Indeed, the focus on the economic model for accelerated economic growth works, but at the expense of the environment and with great harm to the most vulnerable groups of our societies. I would be grateful if you share some thoughts on this. Best. Cristina

Cristina: Thanks for your question, and I look forward to meeting you at Wellesley. An economic model based on mineral extraction has proved to be difficult to implement, not only for the reasons you suggest, namely the effect on the environment and harm to vulnerable groups, but also because mineral rents accrue directly to the government, so there is less scrutiny over how governments spend these rents (as opposed to taxes, which citizens pay to government, and therefore demand accountability). This is why we see poor human-development outcomes, for instance, in oil-rich countries in Africa, such as Gabon or Equatorial Guinea. There are solutions to this problem, however, such as transferring mineral rents as direct dividend payments to citizens, and then taxing them. Regards, Shanta